What happens now that housing boom is over? | Guest column

The latest data on new home sales nationwide are not encouraging. The Commerce Department reported that new home sales declined 8.9 percent in October on a seasonally adjusted basis, and sales have been falling at an annual rate since March.

Indian River County is doing better than the national average, but even here home sales are stalled somewhat, and listed homes remain on the market longer.

The good news is that the 10-year economic expansion from the depths of the last recession has been shouldered, in large part, by the recovery in home sales and investments in the construction of new homes and condos. This housing and construction recovery (at mostly higher prices) has been accompanied by substantial increases in employment and by real income growth throughout the economy. Two cheers.

Housing construction(Photo11: John Bazemore, John Bazemore, AP)

But the disappointing news is that this housing recovery, like almost all previous ones since World War II, is not sustainable in the long run. Indeed, the data seem to indicate we already are in the early stages of the inevitable “bust” phase of that cycle. That phase is usually associated with slower sales, a gradual swelling of inventories, moderating prices and an eventual increase in foreclosures.

The housing market is cyclical because the boom stage is almost always financed by a massive increase in the supply of money and credit by the Federal Reserve. That process is accomplished when the fed purchases government bonds in the open market and pays for them with checks drawn on its own account. And when these checks are deposited, they give rise to additional liquidity throughout the financial system and, eventually, throughout the economy.

Housing and construction are the primary beneficiaries of this credit increase, and these sectors expand smartly in the recovery phase of the business cycle.

But over the last 18 months or so, the Federal Reserve has reversed course. It has been selling government bonds out of its portfolio, and this tends to reduce the supply of money and credit and lead to higher interest rates. Indeed, the fed has raised rates seven times during that period, and has promised additional increases going forward into 2019.

This is not good news for housing.

It is important to understand why the housing market is so hyper- sensitive to changes in the supply of money and credit. The primary reason is that the housing industry is almost uniquely credit-dependent on both the supply and demand side of the market.

On the supply side, the majority of developers work from long-term construction loans which are drawn down monthly. Typically, builders pay an interest rate on the loan that adjusts depending on changes in the so-called prime rate, which is now moving upward. This financing process can be a relatively long one and is especially risky since credit approval, land acquisition and construction can take many years.

Projects that may appear profitable when begun can falter and collapse when interest rates and other costs increase over time.

On the demand side, many households tend to purchase existing homes and new homes with multi-year mortgages that have both fixed and adjustable interest rates as a cost. Higher interest rates increase the monthly payments that service these loans, and that tends to foreclose an entire income class of aspiring buyers from the market. Even homes that are purchased with cash are somewhat interest-dependent since the cash was probably obtained from the sale of an existing home that someone else had purchased ... with borrowed money.

Is the world about to end because the housing market is faltering? Not likely. Although over-extended developers and banks will experience some difficulties, the price of homes will adjust downward and the excess inventories will simply be worked off at lower prices.

Thus, my advise to the Federal Reserve is to ignore the interest-rate criticism by President Trump (a former developer after all) and some economists, and simply stay the course.

Dom Armentano is professor emeritus in economics at the University of Hartford in Connecticut. He lives in Vero Beach.